July 2007

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ESD: Volker Meier

July 24, 2007 in Health Insurance | Permalink

One session of the European Science Days summer school involved a presentation on long-term care (LTC) from Volker Meier. The main question is why is there so little demand for LTC insurance in the United States as well as in other countries? Below are some explanations as to why the LTC insurance market is so small and why–when people do buy LTC insurance–do they make the purchase so late in life:

  • Loading factors. If loading factors are too high, this may possibly justify government intervention. However a paper by Brown and Finkelstein (JPubE 2007) finds that loading factors are comparable to those of life annuities. Meier claims that if there are fixed loading costs, purchasing later in life can save on these costs. However, I believe that these most insurance contracts likely have a fixed and variable loading factor even if economists do not typically model it this way, and this fixed loading cost explanation is likely a poor one.
  • Adverse Selection. It seems likely that individuals have some information regarding the probability they will need LTC in the near future. Most individuals purchase health insurance because there is a non-trivial probability that they will become sick each year. Most younger individuals in good health, however, will not need LTC in the next year. Even if one falls sick, it may be years before LTC is needed. Thus, if one can predict the need for LTC with near certainty two years in advance, no one would purchase LTC insurance.
  • Medicaid. In the U.S., Medicaid pays for about 40% of nursing home stays (Forbes). Thus, poor people have no incentive to purchase LTC insurance since Medicaid will pay. The middle class can run down their assets in the case where they need LTC and have Medicaid foot the bill. Thus, only for the rich will purchase LTC insurance in the United States in order to protect their accumulated assets.
  • Proposal: Matching life insurance with LTC insurance. Peter Zweifel proposed this idea which seems logical. Individuals who live past 65 can use the proceeds from their life insurance policy to pay for LTC insurance. However, there would seem to be significant problems with insurance companies pricing LTC years in advance. Further, healthy individuals who reach age 65 may simply prefer to use the life insurance proceeds to spend on other things. This is especially true if LTC needs are predictable a few years in advance.

Care in a nursing home or care at home

Much debate in Europe and the U.S. has wondered whether paying family members to care for the elderly can save taxpayers money and increase the quality of care. Dr. Meier creates a model with the following characteristics:

  • Individuals fall sick and the cost to care for them is variable. Individuals who go to the nursing home have a cost of Kn, while individuals can also receive care at home for a cost of βiKh, where βminKh < Kn < βmaxKn.
  • βi can depend on the dependent’s opportunity cost or the seriousness of the disease. Thus, we would predict that individuals with better paying jobs and individuals who’s parents have more serious diseases will prefer to put their parents in nursing homes compared to at-home long term care.
  • Another problem with paying individuals to care for their parents at home is the issue of fraud. Individuals can claim to be helping their parents cope with some diseases in order to receive extra cash, even though the work they do may be minimal or non-existent.
  • Meier finds that it is optimal to offer two types of LTC insurance contracts. The first is for full insurance for nursing home care. Another insurance contract will give partial insurance for care at home. The premium for the first contract will be more expensive than for the second. The partial insurance will help to discourage fraud. Meier claims that this is how the German public long-term care insurance operates.

Reading Recommendations:

China Makes, The World Takes

July 23, 2007 in Economics - General | Permalink

There is a very interesting article by James Fallows in The Atlantic Monthly regarding the manufacturing sector in China, with a particular focus on Shenzhen. The article requires a subscription but the Finance Famulus and The Huffington Post websites offer an excerpts.  There is slide show on the Atlantic website for free, however, which also summarizes the article.

Econ Department Rankings

July 20, 2007 in Economics - General | Permalink

Although a little out of date, I came across a recent rankings of U.S. Economics departments. The paper (“Rankings of U.S. Economics Departments“) is written by Richard Dusansky and Clayton J. Vernon and was published in The Journal of Economic Perspectives in 1998. The rankings are as follows:

Rank University
1 Princeton
2 Harvard
3 Pennsylvania
3 MIT
5 Northwestern
6 NYU
7 Boston U.
7 Yale
9 UC-San Diego
9 Stanford
   

As you can see from the scores, my school (UC-San Diego) ranks 9th. Rankings from EconPhD.net have UCSD at number 21 (worldwide), but the most recent U.S. News and World Report Economics Department rankings have UCSD at #10 in the nation. Also a study in Science Watch put UCSD as the 5 th highest impact research institution in the nation from 1995-2005 for business and economics and the 2005 rankings from The Chronicle of Higher Education rank UCSD as #9 in Economics.

The Use of Knowldege in Society

July 19, 2007 in Economics - General | Permalink

On The Library of Economics and Liberty website, there is an interesting article from a Friedrich Hayek‘s 1945 AER paper (“The Use of Knowledge in Society“). The paper begins with a discussion of scientific compared to practical knowledge (i.e.: the knowledge of the particular circumstances of time and place).

“…scientific knowledge, occupies now so prominent a place in public imagination that we tend to forget that it is not the only kind that is relevant. It may be admitted that, as far as scientific knowledge is concerned, a body of suitably chosen experts may be in the best position to command all the best knowledge available—though this is of course merely shifting the difficulty to the problem of selecting the experts”

When academics create economic models, they often assume that practical knowledge is a given. ‘Perfect information’ is a common economic assumption. When finding an equilibrium, economists can calculate the exact quantity of good for a given demand and supply curve. This equilibrium, of course, assumes that there will be no change in supply or demand in the future. Hayek explains:

“One reason why economists are increasingly apt to forget about the constant small changes which make up the whole economic picture is probably their growing preoccupation with statistical aggregates, which show a very much greater stability than the movements of the detail. The comparative stability of the aggregates cannot, however, be accounted for—as the statisticians occasionally seem to be inclined to do—by the “law of large numbers” or the mutual compensation of random changes.”

I am particularly skeptical of macro-economists who claim to have found the steady state equilibrium. While this finding may be true mathematically, a steady state theoretical solution within a world empirically found to be in a constant state of flux is of limited use. Hayek continues:

“If we can agree that the economic problem of society is mainly one of rapid adaptation to changes in the particular circumstances of time and place, it would seem to follow that the ultimate decisions must be left to the people who are familiar with these circumstances, who know directly of the relevant changes and of the resources immediately available to meet them.”

In reality, knowledge, especially practical knowledge is broadly diffused throughout society. Hayek continues on in the essay to rail against the evils of centralized planning and “marvels” and the information imparted through the capitalistic price mechanism. This article is very interesting and certainly deserves a thorough read through the entire article.

ESD: Mathias Kifmann

July 16, 2007 in Public Policy | Permalink

Below is a summary of some of the interesting points in the lecture of Mathias Kifman.

Gouveia model

This is a topping up political economy model. First, we have individuals who get utility from consumption and health care. There are two types: high risk πh and low risk πl. There are also two incomes, yi: rich yr and poor yp. Individuals have the following utility function:

  • max u(c) + πiv(h)
  • c=yi-Πt(y)g
  • h=g

Π is equal to the average risk of the population. The first order condition is:

  • u’Πt(yi)+πiv’

The comparative statics show that dg/dπi is positive (sicker people prefer more government health care), but the sign of dg/dy is unknown. Rich sick people prefer to have some government provided insurance since they can purchase the insurance at a lower rate, but since progressive or proportional taxation finances the system, they dislike the redistribution aspects of this program.

Topping up
We now allow individuals to buy additional medical care, m, even after paying for the public insurance program. For instance, if the government covers 5 doctors visits per year, and individual can buy additional insurance to pay for additional visits. Here, our model is:

  • max u(c) + &pii;v(h)
  • c=yi-Πt(y)g-πmi
  • h=g+m

The first order condition for the choice of m is:

  • -u’(yi-Πt(yi)g-πm)+v’(g+m)=0

The comparative statics reveal the following:

  • dm/dg is negative. More public health insurance will reduce the quantity of private health insurance purchased. This makes perfect sense since in the model public and private health insurance are perfect substitutes.
  • dm/dy is positive. Richer people have higher demand for all goods so it is sensible that they wish to purchase more private health insurance.
  • dm/dπi is negative. Sicker people purchase less private health insurance since the price of private health insurance is based on their risk level. Thus, high risks pay much more for private health insurance than low risks, while in public health insurance the price of health insurance is based on income rather than risk level.

Opting out vs. Topping up
While the topping up model shown above gives a compelling arguement for allowing private health insurance to be purchased in addition to some basic level of public health insurance, one can not always ‘top up’ with medical care. For instance, individuals may wish to avoid public health services altogether in order to avoid waiting list or in order to meet with higher quality doctors. Dr. Kifmann notes the following:

  • If the quality of public services is low, the typical individual prefers private services. Increasing public services (and raising taxes) decreases utility as long as private services are consumed.
  • Once quality is sufficiently high, however, individuals prefer public services. Increasing the quality of public health further can make individuals better off until their preferred qualitz is reached

Of course, it is difficult to ensure quality in a government monopolized system where there is no competition.

Political Economy
The political economy analysis reveals an ‘ends against the middle’ phenomenom. Individuals poorer than the median voter and the wealthiest voters prefer lower services. The poor have a high marginal utility of income and would rather spend their money on themselves rather than a public health care system, while the rich dislike the redistributionary aspect of social health insurance. The middle class, however, generally supports public health insurance. Thus, if the middle class makes up a large proportion of your society, it is more likely that government provided health insurance will be approved by the median voter.

ESD: Louis Eeckhoudt

July 13, 2007 in Economics - General | Permalink

In the forthcoming days, I will be summarizing some of the lectures given at the European Science Days summer school in Steyr, Austria. On the first day, there was an interesting lecture by Louis Eeckhoudt about risk and pain disaggregation.

Most individuals are familiar with the concept of risk aversion. However, the lecture spoke extensively regarding the issue of prudence, presented in a paper by Kimball (1990).

Example

Which lottery would you prefer?

  • In lottery A you have a 1/4 chance of getting 0 € and a 3/4 chance of getting 2000 €.
  • In lottery B you have a 3/4 chance of getting 1000 € and a 1/4 chance of getting 3000 €.

What did you choose? Be honest…

Most people prefer lottery B. Why? The expected value and variance of the two lotteries are identical. However, the skewness of lottery B is positive, but is negative for lottery A. If people are prudent, they choose lottery B. Mathematically, prudence occurs if the third derivative of the utility function is positive (U”’) is positive. Intuitively, people would rather have an upside risk with small probability than a downside risk with small probability even if the mean and variance of the two lotteries are equal.

Dr. Eeckhoudt also introduced the concept of temperance. An individual is temperate if an an exogenous increase in one risk leads them to reduce risk in other areas. Applying this to alcohol, a temparate person would reduce their wine consumption as their beer consumption increase in order to moderate their aggregate risk of getting drunk. Mathematically, temperate individuals have a utility funciton where the fourth derivative (U””) is negative.

Applications to Health

Dr. Eeckhoudt spoke about the well known phenomenon that risk averse people would like to purchase some sort of insurance. If possible, they will self insure. This differs from self-prevention. Let us look at two examples:

  • Self insurance: With probability p, you will become sick and have a utility of x-L(e)-e. With probability 1-p, you will be healthy utility x-e. In this example, by exerting effort, e, you can decrease your health loss L. Thus, the more effort you put forth, the closer will be the two utility levels in each state and thus risk will be dimished.
  • Self-prevention: With probability p(e), you will become sick and have a utility of x-L-e. With probability 1-p(e), you will be healthy and have utility x-e. In this example, by exerting effort, e, you can decrease your the probability of becoming sick, p(e). The key insight from Dr. Eeckhoudt was that more prudent people have a lower level of self prevention!

This is certainly an important societal issue since prudence may decrease healthy behaviors such as self-prevention measures against sickness (e.g.: excercising, quitting smoking, immunizations).

Multi-dimensional prudence
Dr. Eeckhoudt underlying message was that if people prefer to disagregate their pain/risk level, rather than combining losses or risk into a single time period or payoff, this has interesting implications. Let us look at prudence in the mutli-dimensional case.

Each individual recieves utility from income, x, and health, h. The variable s represents sickness and e is a zero mean stochastic term which one could interperet as income risk. Which of the following lotteries should people prefer?

  • In lottery A you have a 1/2 chance of being healthy and having a risky job (x+e,h) and 1/2 chance of having having a safe job but getting sick (x,h-s).
  • In lottery B you have a 1/2 chance being sick and having a risky job (x+e,h-s) and a 1/2 chance of being healthy and having a safe job (x,h).

A prudent person will prefer lottery A to lottery B. In lottery B, sickness and risk are concentrated into one state, where as the risk/losses are disaggregated or spread between the two states.

Health Wonk Review is up

July 13, 2007 in Carnivals | Permalink

The latest edition of the Health Wonk Review is up at the Colorado Health Insurance Insider.

Healthcare Economist going European

July 3, 2007 in Miscellaneous | Permalink

The Healthcare Economist is off to Europe. I’ll be vacationing in Istanbul for about a week.  Afterwards, I will attend the European Science Days summer school on the Economics of Health and Healthcare in Steyr, Austria.

Postings to this blog will resume as soon as I return.

A New Empiricism

July 3, 2007 in Economics - General | Permalink

What is more important: economic theory or testing these theories empirically? In her paper in the Economists’ Voice, Barbara Bergmann calls for “A New Empiricism” in the field of economics.

For instance, the assumption that individuals are rational decision makers may be hard to substantiate empirically.

The researchers [Daniel Kahneman and Amos Tversky] found that in many cases people making choices depart from the behavior that economists had posited as rational. However as Vernon Smith, who developed the field of experimental economics, recently pointed out, it may be that the economists’ notions of what is rational in various contexts needs a reality check.

Gary Becker claims that markets should eliminate racial discrimination. If a company decides not to hire individuals of one race, it will be put at a competitive disadvantage compared to non-racist firms. While markets may work to reduce discrimination somewhat, they definitely do not eliminate it.

Economists have studied the extent of racial discrimination in the labor market by sending out carefully matched black and white “testersâ€? to answer ads for job vacancies, so as to tally differences in treatment. In another study, testers who differed by race and sex but were coached to use similar bargaining tactics were sent out to dealerships to bargain for new cars. In these studies, highly significant differences in treatment by race and sex were found—-non-whites and women were disadvantaged compared to white males.

Dr. Bergmann’s article calls for a logical change in economists’ thinking to focus more on empirical truths of their theories rather than their theoretical elegance.

Stand-up Economist

July 2, 2007 in Economics - General, Miscellaneous | Permalink

If you’re an economist and in need of a laugh, check out the Stand-up Economist’s Principles of Economics, Translated on YouTube.

Is their a difference between micro-economists and macro economists?

  • “The difference of course being that micro economists are people who are wrong about specific things, and macro economists are wrong about things in general.”

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